Farmers have always battled the vagaries of the weather. In the US this year, the worst drought in half a century has crippled crops and left farmers to count the cost. On the other side of the world, Australian farmers are hoping spring delivers the right amount of rain and sun to let them cash in on a 40 per cent spike in wheat and canola prices.

The US drought is the third weather event in five years to cause a spike in soft commodity prices, highlighting the delicate balance between global food production and demand.

This rally has some time to play out. Rabobank recently forecast that food prices were likely to reach record levels next year as the impact of higher grain prices hit beef, poultry and pork producers.

Agriculture is not an industry for the faint-hearted.

AFR
AFR

Investors looking to cash in on the bullish fundamentals need a certain kind of mettle, or at the very least, a longer-term investment horizon.

Wilson HTM analyst James Ferrier points out that unlike many businesses, agricultural companies have assets that will generate commodities and cash-flow decades into the future.

“The assets currently owned by
Tandou
,
Australian Agricultural Company
and others will still be producing in 30 years’ time, and the global population will still need feeding," Ferrier says.

“If you look at other companies, be it retailers, intermediaries or service-based businesses, they might not exist in five years, let alone 30. This concept is often overlooked when investors value agricultural producers, particularly those companies that are listed."

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Australia’s largest beef producer, AAco, is trading below $1.30 a share, well below its net asset backing of $2.13. Cotton farmer Tandou is undergoing a strategic review as its share price lags. Fellow corporate farmer
PrimeAg
, trading well short of its $1.58 net asset backing, has raised a white flat and put itself up for sale.

Australian listed agricultural investments have typically performed poorly. There are exceptions – two bumper East Coast wheat and barley harvests have underpinned strong earnings for grains handler
GrainCorp
, pushing its shares up more than 30 per cent in the past year.

Company directors have long bemoaned a lack of appreciation for agriculture among the nation’s fund managers.

AAco chairman
Donald McGauchie
has argued the short-term focus of fund managers is partly to blame.

There is a lack of in-depth understanding of agriculture markets.

“Australian investors don’t get food security because we have never had to deal with a deficit of food," Ferrier says.

Those looking for a quick buck might have better luck elsewhere. But for those who wonder how world food production can be doubled to feed 9 billion mouths by 2050 –the United Nations Food and Agricultural Organisation forecast – longer-term investments have appeal.

“These people not only need to be fed and need more calories but the quality of what they want to eat increases dramatically," says investment banker David Williams, who has worked on numerous agriculture mergers and acquisitions.

“Someone in China might be eating 2500 calories a day while I am eating 3500 … but they are eating staples and I am eating wagyu. As income rises, calories go up somewhat but the value of the food increases astronomically."

This is why some analysts like companies which help farmers produce more food from the same amount of land.

While demand for food is rising there is a finite amount of farming land. Growing affluence in Asia has also created a greater demand for grain production to fatten livestock.

About 7kg of grain is required to produce 1kg of beef. About 2kg of grain is needed for 1kg of chicken.

For Australian investors the focus has been on fertiliser and mining explosives group
Incitec Pivot
and
Nufarm
, the world’s second-largest generic crop protection company.

Investors are hoping higher soft commodity prices will encourage farmers in its three markets – Europe, the US and Australia – to plant more crops and increase demand in fiscal 2013.

Nufarm shares have gained about 50 per cent this year and earlier this month popped above $6 for the first time since June 2010. It has regained hefty losses sustained two years ago when the company downgraded profit expectations after being caught out by tumbling glyphosate prices, the result of cheap Chinese production. The stock closed at $5.63 on Tuesday.

Nufarm is 23 per cent owned by Japan’s Sumitomo, which many analysts say will consume it in time.

Consolidation is a key theme in agriculture around the world. Investors in listed Australian agricultural stocks have a limited choice due to a spate of mergers and acquisitions driven by large offshore players seeking a greater foothold in the Asian market while diversifying production and geographic risk.

The former wheat marketing monopoly
AWB
was sold to Agrium, which kept the company’s Landmark rural services arm and sold its commodity trading business to the world’s biggest agricultural company, Cargill.

Australia’s fourth-largest sugar miller,
MSF Sugar
, was consumed by Thailand’s Mitr Phol while Singapore’s Wilmar bought up the nation’s biggest producer, Sucrogen, the sugar arm of
CSR
. Olam has bought almond assets, Chinese interests have taken a strategic stake in salmon group
Tassal
while dairy group National Foods was consumed by Lion, owned by Japan’s Kirin.

Analysts are tipping this consolidation will gather pace.

Australia’s proximity to Asia makes it an attractive proposition for the industry’s titans.

GrainCorp, another strong performer in the listed space, is tipped as an attractive target for large grains trading groups such as Glencore. Meanwhile it has been on the acquisition trail itself, buying Australia’s second-largest oilseed crusher Gardner Smith and the edible oils refiner Integro Foods.

GrainCorp has produced back-to-back record profits due to record crop production in Australia. But when droughts strike, its earnings are threatened, hence the acquisition strategy: the company is diversifying its earnings stream.

GrainCorp is tipped as the natural home for
Ridley
’s agrifeeds business. Ridley is in the process of selling its salt division, Cheetham Salts, which could make such a takeover more attractive.

Ridley’s feeds business is counter-cyclical. When conditions are good in the bush, farmers can rely on abundant pastures and the demand for feed declines accordingly.

The patchy performance of Australia’s listed agricultural sector is a prime example of why investors should leverage the soft commodities boom by investing directly in the commodities, says Danny Laidler, managing director of ETF Securities Australia and New Zealand.

“If you are bullish on an individual commodity you can invest in that commodity through an exchange traded commodity (ETC)," Laidler says.

“You can direct investment to the commodity rather than indirect through the company."

Conventional ETCs and ETFs invest in a portfolio of securities, which may include Australian shares, international shares, commodities, currencies, listed property trusts or a combination of asset classes.

Investors can buy an ETC, which tracks the futures price of the chosen commodity.

ETCs are similar to ETFs but provide exposure to commodities whereas ETFs generally provide exposure to equities or fixed interest.

Investors can trade ETCs as they would trade a stock, benefiting from a gain in the futures price, or wearing a loss.

Ferrier says investing in ETCs could be a “wild ride" for many because commodity prices were volatile – spiking on supply shocks and falling on abundant production.

“If you want direct exposure to soft commodity prices, through something like an ETF, then you would be in for a wild ride year to year, but over the long term you would probably be doing pretty well," Ferrier says.

Since it launched its basket of 10 soft commodities ETCs in June, corn prices have rallied 50 per cent and wheat has risen 34 per cent.

Laidler says ETCs are highly liquid, highlighting daily turnover in the Chicago Board of Trade wheat futures contract of more than $US1 billion a day.

“There is huge depth in the market," Laidler says.

Unlike when they buy shares in a company, investors in ETCs do not gain exposure to dividends.

Laidler argues they also avoid the possibility of poor management decisions hurting the value of their asset, even when the commodity price is rallying.

“There may be a management decision that the market doesn’t like and that impacts the share price," Laidler says.

ETCs are traded on the Australian Securities Exchange.

Laidler says the investment is 100 per cent collateralised against assets held by major global banking institutions.

While the broader agricultural theme might be easy to pick, narrowing your investment to a single commodity is harder.

Drought has hurt supply of corn and wheat, pushing up prices, but on the flip side sugar prices are close to two-year lows.

“Sound production prospects in key exporting countries including Brazil, Australia and Thailand, combined with expectations of another Indian surplus, added further weight to sugar prices," Commonwealth Bank of Ayustralia analyst Luke Mathews says.

The net result from the ebb and flow is that food prices are headed up. In a big way.

Rabobank is forecasting world food prices to hit record levels in 2013 as the impact of severe drought in the US and Russia flow through the food chain.

Rabo estimates the UNFAO’s Food Price Index, a measure of global food prices, will rise 15 per cent by the end of June 2013.

However, it says because the prices affected are for grains like corn and oilseeds, which are used for feedstock, the price rally is unlikely to trigger a repeat of the food riots which occurred in 2008, when wheat and rice prices surged.

“The impact of higher grain and oilseed prices will be significant for the animal protein and dairy sectors as they are likely to be squeezed by higher feed costs," says Luke Chandler, Rabobank global head of agri commodities.

“The long production cycles of the animal protein and dairy industries will have lingering effects on global food prices as herds, especially cattle, take longer to rebuild," he says.

Rabo is predicting food prices will hit record highs in the first quarter of 2013 and remain high for most of the year.